Bonus

What is a 'Bonus'

A bonus is any financial compensation, reward, or return over and above the normal expectations of the recipient. A bonus can be given to a company’s employees and executives, prospective employees, or shareholders.

BREAKING DOWN 'Bonus'

In workplace settings, a bonus is compensation given to an employee in addition to his/her normal wage. A bonus can be used as a reward for achieving specific goals set by the company, or for dedication to the company – or even to join the company.

Incentive Bonuses

Examples of bonuses that are offered as an incentive include sign-on bonuses, referral bonuses, and retention bonuses. A sign-on bonus is a monetary offer to prospective employees who are perceived to be top talents. The bonus is meant to incentivize the potential hire to accept a company’s offer of employment over another firm’s offer. The initial payment is designed to entice the signing of an agreement that will cost the company more now for higher future benefits. Professional sport teams, for example, often offer bonuses to highly skilled players they're seeking to sign.

A referral bonus is given to an employee whose recommendation of a person for an open position with the company leads to the hiring of that person. Companies offer referral bonuses to their top performers to refer people whom the employees can vouch for in terms of great work ethics, high skills, and positive attitudes. If the recommended individual ends up getting the job, the recommender will be given a bonus.

Companies offer retention bonuses to key employees to encourage them to stay with the company, especially during stressful periods or during organizational changes. The financial incentive seeks to provide assurance management values their contributions with the company and would like to retain them.

Performance Bonuses

A bonus may also be offered to employees as a reward for some exceptional work that has been done and completed. A performance bonus is offered when a project, quarter, or year has successfully been completed; when a team or employee goes above and beyond the required job responsibilities; or when special recognition is to be given to an employee. The bonus can be given to an individual, a team, a department, or everyone in the company according to each entity’s contribution.

A reward bonus may be a one-time offer or may be a periodic payment. Reward bonuses are not always cash. Sometimes they are paid out in kind in the form of stocks, gift cards, a day off, a holiday turkey, or simply just a verbal appreciation. Examples of bonuses given to an employee for a job well-done include the annual bonus scheme, spot bonus award, employee appreciation award, gain sharing bonus and milestone bonus.

Some businesses have an annual bonus structure built into employees’ contracts. In the event that the firm makes a profit during its fiscal year of operation, the profit will be shared amongst the employees, with executives in the C-Suite getting a larger piece of the pie. The spot bonus award is a micro-bonus payment, typically valued at around $50, given to an employee or team that deserves special recognition. The employee appreciation bonus could also fall under the spot bonus scheme or it could be its own separate award plan given to an exceptional employee. Workers who reach a milestone with the firm, say 10 years of employment, may also be recognized with additional compensation in cash or kind.

Not all bonuses are offered as an incentive or a reward. Some bonus payments made out to employees are not earned,and are given only because the individual is part of the company. Example of a just-because bonus is the holiday bonus, which ranges from payments in cash or kind to all employees to an extra month's salary in addition to the salary for 12 months already received.

Bonus Inflation?

In general, people assume that workplace bonuses are issued to reward workers who have adequate and above-average performance levels, and whose work benefits the company and generates more profit. You'd think a manager who pays bonuses to certain individuals on a lackluster team would likely need to explain his actions both to his boss and to the team members who didn’t receive bonuses.

However, recent studies indicate that close to 25% of all North American managers issue bonuses or some type of financial rewards to even the lower-performing employees. This includes those who fail to meet performance expectations. One study, conducted by Towers Watson Talent Management and Rewards Pulse Survey, also indicated that just short of 20% of these managers do not set any differences in target payouts based on employee performances.

Research reveals that businesses that reward all staff, disregarding performance, generally tend to grow more slowly and in many cases end up generating less money. Lack of successful and effective management of employee performance typically causes companies to lose profits. However, the majority of businesses in the United States are still rewarding mediocre employees, and there are a number of reasons why.

Impact on Management and Employees

Performance-based bonus systems, particularly those that are extremely restrictive, cause substantial headaches, mainly in the shape of staffer complaints, lower morale and anger – taken out on management, colleagues and sometimes even on customers and clients. As a result, bonuses are often issued to even the poorest-performing workers, to avoid dealing with backlash: It's simply easier to pay bonuses to all employees. This allows management to avoid discussing inadequate performances with employees and explaining why they weren't given bonuses, or were given smaller bonuses than their better-performing co-workers. Even chief executive officers (CEOs) who have tried to implement strictly numbers-based reward-and-punishment bonus systems have found great difficulty in doing so.

Then too, it is often difficult to judge the rate of performance, even when using "objective" measures. For example, judging an employee on his failure to meet a certain quota or deadline is not always a good indicator of how hard the employee is working or how valuable he is to the company: The worker may be struggling against unavoidable production delays or downward trends in the economy. Finally, some companies may try to use bonuses not as a reward for good work in the past year, but as an incentive for better work in the future – in effect, a bribe to boost workers' overall performances going forward.

Bonuses in Place of Pay

There's another reason every worker might receive, or at least be promised, a bonus. Within the past decade or so, companies have increasingly been replacing raises in salary partially or entirely with bonuses, a change affecting everyone from the senior executives to the secretaries and assistants. It's a cost-saving measure that, according to Aon Hewitt’s 2014 Salary Increase Survey, companies across the United States are now using in record numbers, much to the detriment of the employees. Employers keep wages and wage increases low by promising to fill the gap with bonuses; when bonus time comes, though – traditionally, at the end of the year – there’s no obligation to actually pay out.

Because employers pay bonuses on a discretionary basis, they’re able to keep their fixed costs low by shifting heavily to a bonus system. Such variable pay can be adjusted to suit the economic health of the company and, in slow years, can be written off entirely. Compare this to a company that increases salaries every year and then tries to cut wages during a recession. It rarely happens.

The increased control over wages has additional benefits aside from its flexibility. For starters, wage increases, once implemented, grow exponentially as each year’s increase is based off of the previous year’s salary. What’s more, Social Security, payroll taxes and pension contributions are all based on salary: Save on salary costs, save on benefit costs. It’s a win-win for any organization.

Another unnerving statistic is the amount in bonuses that are actually given out, specifically to top-performing employees. According to recent studies, American companies have just over 85% of the money they previously earmarked to be available for bonuses for their employees. Since 2005, U.S. companies have only had 100% of bonus funds available to reward employees twice – in 2006 and in 2010.

Other Bonus Types

In addition to employees, shareholders may also receive a bonus as a return on their investment with the company. One type of shareholder bonus is dividends, which are paid to shareholders from funds created out of profits realized by the company. The board of directors has to approve dividend payments, and can also decide to stop the payments at its discretion.

A company can also issue bonus shares to shareholders, thereby increasing the total number of shares issued and owned. A bonus issue is usually based on the number of shares already owned by the shareholder, and is very similar to a stock split, except that no splits occur with bonus shares and the figures in the Shareholders' Equity section of the balance sheet changes.

Bonus plans are not limited to office employees and shareholders. Other stakeholders in the company’s supply chain may receive additional compensation, such as sign-on bonuses, from a company in order to close a deal or obtain a contract.